Overnight Futures Ramp Right On Schedule

At this point it has gotten painfully tedious, and the one phrase to describe trading is - Same Pattern Different Day. With equity futures closing decidedly weak on earnings reality after US market close, the slowly, steady overnight ramp seen every single day for the past month has returned as always, this time on yet another largely expected German confidence indicator beat (following the just as irrationally exuberant ZEW some time ago, and yesterday's far better than expected PMI), this time the IFO Business Climate, which printed at 104.2, on expectations of 103 and up from 102.4. This was driven by both the current assessment rising from 107.1 to 108 and the Expectations rising from 97.9 to 100.5. Naturally, all confidence indicators will be skewed in a way to prevent the market from doubting for a second that Germany may actually succumb to the same recession that has gripped all other European countries (which Germany is an inch away from after its negative Q4 GDP). In other words: there is hope. As for reality, UK Q4 GDP came in at -0.3% on expectations of a far lower drop to -0.1%, and down from the olympics-boosted 0.9% in Q3. The UK certainly can't wait for Mark Carney to come and show them how cable devaluation is really done, cause this time it will be different, if only it wasn't different for everyone else.

But the most anticipated news of the day was the previously reported LTRO repayment, which came in far "stronger" than expected. Initially this was taken as positive as it means the ECB's balance sheet will shrink at a time when everyone else is engaging in open balance sheet busting FX warfare, even if in reality this is a deflationary outcome leading to even more appreciation for the EURUSD, and even more pain for both the European trade and current account balance. As Deutsche Bank explained, "the market will likely continue to have some focus on the fact that the ECB balance sheet is likely to be steadily shrinking for a period at a time when the Fed is effectively increasing its by $85bn/month and where Japan is seen by many to be set to notably increase its interventions. So while the repayments are not a big deal in themselves the contrast between the ECB and many other central banks means that the Euro is probably biased to appreciate for the foreseeable future. This might provide an unwelcome headwind for growth in Europe later in the year." And, naturally, a few hours before the LTRO announcement, none other than Italy's Monti said that a strong EUR could harm exports, something we already showed for Spain.

More from Deutsche Bank:

Today is the day the ECB unofficially starts to exit from unconventional monetary policy as Euro-area banks now have the option to repay some of the 1 trillion Euros of LTRO money afforded to them last year. Banks can now hand back money with one week's notice, and today at 11am London time is the first announcement of what they have initially done. It’s likely that any repayment will be biased towards stronger banks and as such there's no real immediate systemic risk from this story. However the market will likely continue to have some focus on the fact that the ECB balance sheet is likely to be steadily shrinking for a period at a time when the Fed is effectively increasing its by $85bn/month and where Japan is seen by many to be set to notably increase its interventions. So while the repayments are not a big deal in themselves the contrast between the ECB and many other central banks means that the Euro is probably biased to appreciate for the foreseeable future. This might provide an unwelcome headwind for growth in Europe later in the year. Despite the promise of the OMT, Europe is in danger as being seen as the least active in the near-term in the currency war skirmishes that are focusing investors minds at the moment. Maybe actions elsewhere and a higher Euro will eventually lead to the ECB balance sheet expanding again after some market stress but this is further down the road.

While on European matters, Draghi is expected to speak at Davos today at 930am London time so it'll be interesting to hear if he continues to give off an air of increased confidence and whether he discusses the currency at all. Data wise Europe had a mixed day yesterday but the US was strong. In terms of the flash PMIs, Germany (48.8 vs 47.0 expected for Manufacturing, and 55.3 vs 52.0 for Services) was strong but weakness in France (42.9 vs 44.9 expected for Manufacturing, and 43.6 vs 45.5 expected for Services) was notable. The overall European number beat expectations but Germany played a large part in this. Our European economists think that these numbers are consistent with a flat Italian and Spanish composite reading when the data comes out next Friday. The Flash Markit US PMI number was very strong (56.1 vs 53.0). This release is still in its infancy with little track record but if it’s close to being consistent with the official ISM then US markets are not mis-priced at current levels. Indeed in our ISM/S&P 500 simple regression model, at current levels US equities are broadly pricing in an ISM of 54.7. The last ISM was at 50.7 though so the flash PMI is well ahead for now and a bit of caution is required. In Europe the market is much more ahead of the economy as our simple model suggests that equities are broadly pricing in a French, German and Euro-area PMI of 54.5, 56 and 54, respectively (against yesterday’s flash manufacturing numbers of 42.9, 48.8 and 47.5). This is all quite sweeping but in general the US economy is showing signs that it might be living up to some of the faith the equity market has recently shown in it whereas Europe still has a long way to go.

As we said in the 2013 outlook, liquidity and the benefit of the doubt will likely dominate in Q1 and market should generally be in decent shape. However we do need to see Europe show more consistent and broad growth for European markets not to have a set-back in Q2. The jury is still out on this and a steadily increasing Euro won't help.

Moving on to the market, yesterday saw the S&P 500 breach the symbolic 1500 mark for the first time since 2007 before chatter of a Financial Transactions Tax helped reverse all of those earlier gains. US data flow was generally positive supported by a larger-than-expected drop in initial jobless claims (330k v 355k) and the stronger preliminary PMI as mentioned above. Although we should note that the regional manufacturing surveys from the Kansas Fed yesterday (-2 vs +1) and the Richmond Fed on Tuesday (-12 v +5) were both disappointing.

The S&P 500 finished the day virtually unchanged with the NASDAQ (-0.74%) being a standout underperformer amongst major indices as sentiment for Tech stocks softened on the back of Apple’s results.

Turning to Asia and overnight markets are mixed. The Nikkei (+2.5%) is leading the pack as the continued fall in consumer prices probably added further easing optimism. Core CPI fell - 0.6% yoy in December which is a touch more than expected (-0.5% yoy).

The JPY fell to 90.5 against the Dollar and is now 2.7% off the intra-week highs. Elsewhere the Hang Seng (- 0.3%) and the KOSPI (-1.1%) are both lower with the latter particularly being impacted by the renewed weakness in JPY.

In other news EU’s Olli Rehn said that he is unsure that the Euro is overvalued now but would not want to see a currency war of competitive devaluations which would have a negative effect on the Euro. On the peripheral countries, Rehn said there are several options under consideration to help Dublin and Lisbon return to markets including possibly extending the maturity of bailout loans or providing a new precautionary credit line.

In terms of today, Germany’s IFO survey and UK GDP for the fourth quarter will be the data highlights in Europe. The New home sales report is the only major release in the US. So all eyes will be on the ECB’s LTRO prepayment announcement and Draghi’s speech at Davos today.

The 2007 Federal Open Market Committee (FOMC) transcripts were released last week. Media reports have concentrated on the Fed's forbearance during the credit meltdown. Implied, but not stated (in what I have read) is the major reason for such nonchalance: The Fed only acknowledges flows, not stocks. This might sound boring. It is also very important to understand.

This approach to central banking has not changed. All of the major central banks use the same framework. The media and Wall Street spend most of their time interpreting the meaning of central-bank talk. Central banks will never mention a growing concern about loan defaults since the academics can always thwart potential catastrophes by modeling preventive flows (e.g., liquidity). The catastrophic financial failure that most of us endured in 2007 and 2008 was not a failure at all, according to central bankers. Their models still conclude there is always a central-banking solution that will prevent any catastrophe. In conclusion: when the current financial bubble topples, there will no forewarning from central bankers, the media, or Wall Street. Given their processes of thinking, they will be more surprised than the average hairdresser.

"Stocks," in this case, does not refer to common stocks, but the accounts and categories in which assets (and their liabilities) accumulate. The Fed, a creature of academia, knows everything. Knowing everything limits policy to sufficient "liquidity": flows. It - to be more precise - its DSGE model, does not care about accumulations: stocks.

The Fed was taken unaware when credit cracked up in the summer of 2007. Unlike many local realtors and carpenters, the FOMC did not understand the connection between flows (bad loans pouring into off-balance sheet Special Investment Vehicles) and stocks (of mushrooming mortgage credit going sour). The Fed presumably noticed pieces of the mortgage machine (subprime lenders, appraisers, Fannie Mae, commercial banks, investment banks, CDOs) even though it did not comprehend the artificiality of this contrived structure. Hence, the Fed missed the connection between the economic expansion of the mid-oughts and its artificial nature. (As we know now, the Fed does not blanch at running an economy by rigging its prices, so, we know now, central banks do not understand an artificial economy is unsustainable.)

All of which is to say the Fed and its FOMC did not know a loss of forward momentum would be followed by an abrupt shift to backward momentum. Again, this has not changed. Despite talk of deleveraging, the U.S. economy has continued to lever up since the non-catastrophe of 2007 and 2008. Total non-financial debt has risen from 240% of GDP in the fourth quarter of 2008 to 249% of GDP after the second quarter of 2012.

The Fed does not understand the artificial credit created by central banks that has flowed since 1971 has coagulated into unsustainable imbalances around the world. The FOMC will be in the caboose when government debt loses its imaginary, "riskless" character (e.g., banks do not need to reserve against most sovereign bonds). As in 2007 and 2008, the stated price of artificially produced assets is illusory, so the assets cannot stand on their own without ever increasing flows to support prices. The flows accumulate in stocks, the artificial composition of which will topple.

IEF2 program by the CME allows banks and large institutions to deposit their Money Market Fund Shares as collateral with the CME. They then leverage the money funds to go buy Futures. Low quality assets in money funds to begin with are then leveraged by CME. When the unwind comes and CME has to liquidate low quality assets in money funds... it will be a disaster.

Seems the plan is to push into the 1500s and hold for most of today, then fall back to exactly 1500 on the close (to provide suspense for next week), then for a mini-plunge next week to sucker in more shorts, after which they'll be squeezed like lemons through mid-March to "new, new all-time highs" then, just as Uncle Louis' 401(k) re-allocation to stocks is completed, the Big Plunge of April will happen, followed by summer flat doldrums, then another ramp into the holidays. Sounds familiar, as the script-writer is a robot.

Jamie D. said yesterday he "likes stocks here", but didn't specify he likes them long in our IRAs, but as soon-to-be shorts on his bank's books.

SP 1500 by the close on the Friday before the Super Bowl seems like a sure bet to me. Buck Fernankie will not let the American sheeple worry about their 401ks for the biggest football game of the year.